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MyMomLovesMe wrote:
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The biggest miss is ignoring the impact of cash flow.
If a business is operating at negative cash flow every expense added (interest, practice facility, whatever) makes them go more negative in cash flow.
Every loan taken out might increase the value of the franchise if used appropriately however you still have to repay the debt and pay the interest when you are already cash flow negative. Where does the money come from to handle MORE expenses when you are already operating at negative cash flow i.e. a LOSS?
Maybe this gives a better indication I hear where you are coming from:
I bought a house in May 2007 as a rental and sold it in July 2008 for a profit of $38K. I took all those profits and rolled it in to another rental property that I bought at a discount because it needed serious renovations. When finished I had a property valued at more than the cost plus renovations and I had a better cash flow on the new property (+$450 per month on old versus +$1200 per month on the new) plus I paid no capital gains on the sale because the expenses in the renovations were greater. The difference here is I was operating at a profit.
For many NBA owners they are operating at a loss. So you are saying the owners should take out more loans against their franchises to increase the value of the asset while increasing their expenses all the while operating at a loss, forgetting operational costs because they don't matter? If they don't matter, then why do businesses go out of business?
When expenses and depreciation exceed revenues, the extra expenses and depreciation are not helping the business because you can't claim any extra expense or depreciation if there are no revenues left. You can only keep operating like this as long as you can keep taking loans to cover costs. At some point the cost to cover the loans becomes greater than the revenues themselves - forgetting all the other expenses.
Also when you are operating at a loss year over year, as many owners claim to be, what is the point of carrying losses over against more losses? At some point you need to make a profit to claim a loss.
This is the problem from the owners perspective: expenses exceed revenues.
Your answer to cover costs through loans against an asset is leverage (there is no capital gain because a capital gain requires a sale). Leverage is a great tool when asset prices are rising. When they are stagnant or, worse, dropping losses are magnified even more.
As for your smart business owner: what happens when the tool breaks with no warranty and the building needs a new roof while operating at negative cash flow? Where does the money come from? A loan of course. What happens when it is time to pay interest and principle and he has already been operating cash flow negative?
Something the auditor for CRA in my family said to me a couple of years ago when I had exhausted every method possible to reduce my tax bill (depreciation, expenses, maintenance, repairs, personal use items, etc.) and it was the first time I had ever paid in on my taxes: Don't sweat paying taxes, it means you've made money.
Your answer for the owners is to continue to loss $1 for every 25 cents gained (assuming marginal tax rate is 25%). Your answer only makes sense for owners if they are being taxed at over 100%.
Lets put it another way, these are the owners choices for every $1:
1) get 75 cents and give 25 cents to the taxman operating at a profit,
2) lose $2.12 by losing $1 in operational costs and then give another $1 to a contractor plus pay the interest (say 6%) on the loan to cover operational costs and construction operating at a loss.
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